Maryland Court of Special Appeals Rules Against Taxpayer’s Out-of-State Intangible Holding Company Structure

In Comptroller of the Treasury v. W.L. Gore (decided January 24, 2013), the Maryland Court of Special Appeals reversed the Cecil County Circuit Court and upheld the Maryland Tax Court’s ruling that Gore was required to apportion income from its out-of-state intangible holding company (GEH) and investment subsidiary (FVI) to Maryland. In 1983, Gore created GEH in Delaware to which it transferred all of its patents, and in 1996 it created FVI in Delaware to which it contributed all of its financial assets. Gore paid royalties to GEH for use of the patents and interest income to FVI for loans annually. Gore did not apportion any of GEH or FVI’s earnings to Maryland, claiming they were separate businesses with no Maryland nexus.

In 2006 the Comptroller audited Gore and determined that it was required to apportion GEH and FVI income to Maryland because neither GEH nor FVI had real economic substance as business entities separate and apart from Gore. The Tax Court upheld the Comptroller’s determination but was reversed by the Cecil County Circuit Court.

In its decision, the Court of Special Appeals stated that Maryland may apportion a part of a corporation’s multi-state business income to Maryland if the intrastate and out-of-state activities formed part of a single “unitary” business. The Court stated that “[T]he hallmarks of a unitary relationship are: 1) functional integration, 2) centralized management, and 3) economies of scale.” Here, the Court found that in addition to an accounting identity (Gore generated Maryland income and deducted payments to GEH and FVI, which then recognized the same income), GEH and FVI remained under Gore’s complete control and served only to advance Gore’s interests. For example, GEH and FVI shared directors, executives, and employees with Gore and were dependent on Gore for their core business functions.

This case represents another taxpayer loss in the area of out-of-state intangible holding companies for state tax planning. In 2010, the Maryland Court of Special Appeals held that Classics, an out-of-state wholly owned subsidiary of Talbots, was taxable in Maryland on a portion of the royalty income Talbots paid to it to license the Talbots trademarks. Similarly, also in 2010 the Maryland Tax Court (on remand from the Baltimore County Circuit Court) held that an out-of-state Nordstrom subsidiary was taxable in Maryland on a transfer, as a dividend, of a license agreement authorizing the right to license the use of Nordstrom trademarks to its parent, another out-of-state Nordstrom subsidiary. With state revenues tight we expect Maryland and other states to continue challenging these types of out-of-state holding company structures.

For further information regarding out-of-state holding company structures or other tax planning issues, please contact Joseph A. Rieser, Jr.

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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